Capital Market Participants, Instruments

Participants

Loan Takers: A huge number of organizations want to take a loan from the capital market. Among them, the following are prominent as Govt. organizations, Corporate bodies, Non-profit organizations, Small business, and Local authorities.

Loan Providers: These types of organizations provide loans to my capital market. Others can take the loan from the loan providers such as savings organizations, insurance organizations etc.

Service organizations: Service organizations help to run capital market perfectly. These firms, on one hand, help issuers or underwriters to sell their instruments with high value and in other hand help sellers and buyers to transact easily. These are mainly service organization – invests banks, Brokers, Dealers, Jobbers, Security Exchange Commission, Rating service, Underwriters etc.

Financial intermediaries: Financial intermediaries are media between loan providers and takers. The financial intermediaries are Insurance organizations, Pension funds, Commercial banks, financing companies, Savings organizations, Dealers, Brokers, Jobbers, Non-profit organizations etc.

Regulatory organizations: Regulatory organizations are mainly govt. the authority that monitors and controls this market. It secures both the investors and corporations. It strongly protects forgery in stock market Regulatory organization controls the margin also. The Central bank, on behalf of govt. generally controls the financial activities in a country.

Instruments

Government Securities:

Securities issued by the central government or state governments are referred to as government securities (G-Secs).

A Government security may be issued in one of the following forms, namely:

1. A Government promissory note payable to or to the order of a certain person,
2. A bearer bond payable to bearer
3. A stock
4. A bond held in a ‘bond ledger account,

Bonds:

Bonds are debt instruments that are issued by companies/governments to raise funds for financing their capital requirements. By purchasing a bond, an investor lends money for a fixed period of time at a predetermined interest (coupon) rate. Bonds have a fixed face value, which is the amount to be returned to the investor upon maturity of the bond.

During this period, the investors receive a regular payment of interest, semi-annually or annually, which is calculated as a certain percentage of the face value and known as a ‘coupon payment.’ Bonds can be issued at par, at discount or at premium. A bond, whether issued by a government or a corporation, has a specific maturity date, which can range from a few days to 20-30 years or even more.

Both debentures and bonds mean the same. In Indian parlance, debentures are issued by corporates and bonds by government or semi-government bodies. But now, corporates are also issuing bonds which carry comparatively lower interest rates and preference in repayment at the time of winding up, comparing to debentures.

The government, public sector units and corporates are the dominant issuers in the bond market. Bonds issued by corporates and the Government of India can be traded in the secondary market.

Basically, there are two types of bonds viz.:

1. Government Bonds: Are fixed income debt instruments issued by the government to finance their capital requirements (fiscal deficit) or development projects.
2. Corporate Bonds: Are debt securities issued by public or private corporations that need to raise money for working capital or for capital expenditure needs.

Types of Government Securities:

Following are the types of Government Securities:

1. Promissory Notes:

Promissory Notes are instruments containing the promises of the Government to pay interest at a specified rate. Interests are usually paid half yearly. Interest is payable to the holder only on presentation of the promissory notes. They are transferable by endorsement and delivery.

2. Stock Certificates (Inscribed Stock):

Stock certificate, also known as Inscribed Stock, is a debt held in the form of stock. The owner is given a certificate inserting his name after registering in the books of PDO of RBI. The execution of transfer deed is necessary for its transfer. Since liquidity is affected, these are not much favoured by investors. One will have to wait till maturity to get it encashed.

3. Bearer Bonds:

A bearer bond is an instrument issued by government, certifying that the bearer is entitled to a specified amount on the specified date. Bearer bonds are transferable by mere delivery. Interest Coupons are attached to these bonds. When the periodical interest falls due, the holder clips off the relevant coupon and presents it to the concerned authority for payment of interest.

4. Dated Securities:

They are long term Government securities or bonds with fixed maturity and fixed coupon rates paid on the face value. These are called dated securities because these are identified by their date of maturity and the coupon, e.g., 12.60% GOI BOND 2018 is a Central Government security maturing in 2018, which was issued on 23.11.1998 bearing security coupon 400095 with a coupon of 12.06 % payable half yearly. At present, there are Central Government dated securities with tenure up to 30 years in the market. Dated securities are sold through auctions. They are issued and redeemed at par.

5. Zero Coupon Bonds:

These bonds are issued at discount to face value and to be redeemed at par. As the name suggests there is no coupon/interest payments. These bonds were first issued by the GOI in 1994 and were followed by two subsequent issues in 1995 and 1996 respectively.

6. Partly Paid Stock:

This is a stock where payment of principal amount is made in installments over a given time frame. It meets the needs of investors with regular flow of funds and the needs of Government when it does not need funds immediately. The first issue of such stock of eight year maturity was made on November 15, 1994 for Rs. 2000 crore. Such stocks have been issued a few more times thereafter.

7. Floating Rate Bonds:

These are bonds with variable interest rate, which will be reset at regular intervals (six months). There may be a cap and a floor rate attached, thereby fixing a maximum and minimum interest rate payable on it. Floating rate bonds of four year maturity were first issued on September 29, 1995.

8. Bonds with Call/Put Option:

These are Govt. bonds with the features of options where the Govt. (issuer) has the option to call (buy) back or the investor can have the option to sell the bond (Put option) to the issuer. First time in the history of Government Securities market RBI issued a bond with call and put option in 2001-02. This bond was due for redemption in 2012 and carried a coupon of 6.72%. However the bond had call and put option after five years i.e. in the year 2007. In other words, it means that holder of bond could sell back (put option) bond to Government in 2007 or Government could buy back (call option) bond from holder in 2007.

9. Capital Indexed Bonds:

These are bonds where interest rate is a fixed percentage over the wholesale price index. The principal redemption is linked to an index of inflation (here wholesale price index). These provide investors with an effective hedge against inflation. These bonds were floated on December, 1997 on an on tap basis. They were of five-year maturity with a coupon rate of 6 per cent over the wholesale price index.

10. Fixed Rate Bond:

Normally government securities are issued as fixed rate bonds. In this type of bonds the coupon rate is fixed at the time of issue and remains fixed till redemption.

Gold bonds, National Defence bonds, Special Purpose Securities, Rural Development bonds, Relief bonds, Treasury bill etc. are other types of Government securities.

The major investors in G-Secs are banks, life insurance companies, general insurance companies, pension funds and EPFO. Other investors include primary dealer’s mutual funds, foreign institutional investors, high net-worth individuals and retail individual investors.

Most of the secondary market trading in government bonds happens on OTC (Over the Counter), the Negotiated Dealing System and the wholesale debt-market (WDM) segment of the National Stock Exchange.

Debentures:

Debenture is an instrument under seal evidencing debt. The essence of debenture is admission of indebtedness. It is a debt instrument issued by a company with a promise to pay interest and repay the principal on maturity. Debenture holders are creditors of the company. Sec 2 (12) of the Companies Act, 1956 states that debenture includes debenture stock, bonds and other securities of a company. It is customary to appoint a trustee, usually an investment bank- to protect the interests of the debenture holders. This is necessary as debenture deed would specify the rights of the debenture holders and the obligations of the company.

Types of Debentures:

1. Secured Debentures:

Debentures which create a charge on the property of the company is a secured debenture. The charge may be floating or fixed. The floating charge is not attached to any particular asset of the company. But when the company goes into liquidation the charge becomes fixed. Fixed charge debentures are those where specific asset or group of assets is pledged as security. The details of these charges are to be mentioned in the trust deed.

2. Unsecured Debentures:

These are not protected through any charge by any property or assets of the company. They are also known as naked debentures. Well established and credit worthy companies can issue such shares.

3. Bearer Debentures:

Bearer debentures are payable to bearer and are transferable by mere delivery. Interest coupons are attached to the certificate or bond. As interest date approaches, the appropriate coupon is ‘clipped off by the holder of the bond and deposited in his bank for collection. The bank may forward it to the fiscal agent of the company and proceeds are collected. Such bonds are negotiable by delivery.

4. Registered Debentures:

In the case of registered debentures the name and address of the holder and date of registration are entered in a book kept by the company. The holder of such a debenture bond has nothing to do except to wait for interest payment which is automatically sent him on every payment date.

When such debentures are registered as to principals only, coupons are attached. The holder must detach the coupons for interest payment and collect them as in the case of bearer bonds.

5. Redeemable Debentures:

When the debentures are redeemable, the company has the right to call them before maturity. The debentures can be paid off before maturity, if the company can afford to do so. Redemption can also be brought about by issuing other securities less costly to the company in the place of the old ones.

6. Convertible Debentures:

When an option is given to convert debentures in to equity shares after a specific period, they are called as convertible debentures.

7. Non-Convertible Debentures With Detachable Equity Warrants:

The holders of such debentures can buy a specified number of shares from the company at a predetermined price. The option can be exercised only after a specified period.

Preference Shares:

The Companies Act (Sec, 85), 1956 describes preference shares as those which Carry a preferential right to payment of dividend during the life time of the company and Carry a preferential right for repayment of capital in the event of winding up of the company.

Preference shares have the features of equity capital and features of fixed income like debentures. They are paid a fixed dividend before any dividend is declared to the equity holders.

Types of Preference Shares:

1. Redeemable Preference Shares:

These shares are redeemed after a given period.

Such shares can be repaid by the company on certain conditions, viz.;

1. The shares must be fully paid up.
2. It must be redeemed either out of profit or out of reserve fund for the purpose.
3. The premium must be paid if any.

A company may opt for redeemable preference shares to avoid fixed liability of payment, increase the earnings of equity shares, to make the capital structure simple or such other reasons.

2. Irredeemable Preference Shares:

These shares are not redeemable except on the liquidation of the company.

3. Convertible Preference Shares:

Such shares can be converted to equity shares at the option of the holder. Hence, these shares are also known as quasi equity shares. Conversion of preference shares in to bonds or debentures is permitted if company wishes. The conversion feature makes preference shares more acceptable to investors. Even though the market for preference shares is not good at a point of time, the convertibility will make it attractive.

4. Participating Preference Shares:

These kinds of shares are entitled to get regular dividend at fixed rate. Moreover, they have a right for surplus of the company beyond a certain limit.

5. Cumulative Preference Shares:

The dividend payable for such shares is fixed at 10%. The dividend not paid in a particular year can be cumulated for the next year in this case.

6. Preference Shares with Warrants:

This instrument has certain number of warrants. The holder of such warrants can apply for equity shares at premium. The application should be made between the third and fifth year from the date of allotment.

7. Fully Convertible Cumulative Preference Shares:

Part of such shares, are automatically converted into equity shares on the date of allotment. The rest of the shares will be redeemed at par or converted in to equity after a lock in period at the option of the investors.

Securities:

‘Securities’ is a general term for a stock exchange investment.

Securities Contract (Regulation) Act, 1956 defines securities as to include:

1. Shares, Scripts, Stocks, Bonds, Debentures.
2. Government Securities.
3. Such other instruments as may be declared by the Central government to be securities.
4. Rights or interests in securities
5. Derivatives
6. Securitized instruments

Equity Shares:

Equity Shares are the ordinary shares of a limited company. It is an instrument, a contract, which guarantees a residual interest in the assets of an enterprise after deducting all its liabilities- including dividends on preference shares. Equity shares constitute the ownership capital of a company. Equity holders are the legal owners of a company.